The D&O insurance market is looking anxiously to Washington D.C. this week as the Supreme Court hears arguments in Halliburton v. Erica P. John Fund. One of the big concerns surrounding this case is the potential impact on the “fraud on the market” presumption for class action litigation.
Reuters’ Allison Frankel has a full write-up of oral arguments from Wednesday, March 5 here – we’ve highlighted a few key paragraphs below.
Justice Anthony Kennedy was the first to raise the possibility of a compromise that would not entirely undermine Basic’s adoption of fraud-on-the-market theory, which assumes that market prices reflect all available public information. Well into Halliburton counsel Streett’s argument, after Justice Elena Kagan questioned him skeptically about why the court should even consider overturning Basic and Chief Justice John Roberts expressed reluctance to wade into the morass of economic literature on efficient market theory, Kennedy asked Streett to address “the midway position that says there should be an event study.” An analysis of price impact, he said, would seem to be “a substantial answer to…the challenge you make to the economic premises of the Basic decision.”
Kennedy noted that his question was based on an amicus brief by two law professors – he didn’t name them, but the brief is by John Elwood of Vinson & Elkins for Adam Pritchard of the University of Michigan and Todd Henderson of the University of Chicago – who argued that price impact is a cleaner, clearer test of whether market price is impacted by fraud than Basic’s efficient market framework. The brief advocates the use of event studies at the class certification stage of securities litigation to determine whether alleged misrepresentations truly distorted the market. Under this framework, investors could proceed as a class only if they could show evidence that the market has actually been defrauded.
As arguments continued Wednesday morning, the justices struggled to figure out exactly how the price impact requirement would work in practice, especially considering that just last term, inAmgen v. Connecticut Retirement Plans, the court said that it would not require shareholders to prove the materiality of alleged misstatements in order to be certified as a class. (As you probably recall, the court’s ruling in Amgen, in which four justices suggested that Basic’s presumption of reliance deserved re-examination, prompted Halliburton to ask that question in its certiorari petition.) Chief Justice Roberts wanted to know whether event studies to show price impact would be more expensive than market efficiency studies that securities class action plaintiffs now rely upon at the class certification stage. (Streett said not necessarily, Boies said yes.) Justice Breyer asked why defendants couldn’t already use event studies showing no price impact to oppose class certification motions; Halliburton counsel Streett pointed out that his client’s case was spurred by the 5th Circuit Court of Appeals’ refusal to consider exactly such evidence.
Justice Sotomayor was particularly uncomfortable with Kennedy’s suggested “midway” compromise. “I don’t see how this is a midpoint,” she said to Streett. “If you’re going to require proof of price, impact, why not do away with market efficiency?” Requiring proof of price impact at the class certification stage, Sotomayor said, would turn class certification into “a full-blown merits hearing.” Sotomayor later posed the same question to Boies: “If we believe price impact is necessary, why keep Basic if we’re going to put it in a class certification (hearing)?” Boies said price impact is a merits question, not a class certification question, which prompted Justice Kennedy to ask why price impact couldn’t be considered a class certification issue. “Even if Basic did not rely on economic theory, and there is a dispute on that…if later economic theories show that the market doesn’t react the way Basic assumed it automatically did, then certainly Congress would not wish to foreclose the court from considering that new evidence,” Kennedy said, in a question that implicitly noted that the certification process for securities fraud cases rests on Basic’s fraud-on-the-market theory.
We will keep an eye on this case as it progresses – both here and in our industry news feed on the PLUS website.